Friday, March 2, 2012

Don't Mess With My VRS!

On Tuesday of this past week, the Virginia Pension Protection Coalition brought in three national level experts on pension policy. Monique Morressey of the Economic Policy Institute offered excellent testimony. I thought I would share it with you today. If you haven't done so, please go the www.veanea.org and send a letter to your delegate and your senator on this issue. You'll see the hotlinks to the letters in the upper right hand portion of the page.

Draconian changes to the Virginia Retirement System proposed by both houses of the Virginia General Assembly would not only have a deleterious effect on the retirement security of public employees, but also greatly hinder the ability of school systems and other public employers to attract and retain skilled workers, eroding the quality of education and other public services. People don’t go into public service to get rich—salaries are around 20% below what workers with the same education earn in the private sector—but state and local government workers are at least assured of secure benefits.

Pensions, in particular, are probably the single most important recruitment and retention tool public employers have in their toolbox. Both the House and Senate bills, however, would scrap this essential and highly-cost-effective tool—both by gutting benefits and, in the case of the Senate bill, by siphoning off funds and destabilizing the system.

The House bill also amounts to a breach of trust, since benefit cuts would affect not just future workers going forward but also current employees who chose their careers based in part on the promise of a secure retirement. While many workers may have little choice but to remain on the job, especially in this economy, the cost savings achieved by this bait-and-switch would be short-lived because of the effect on recruitment going forward.

In contrast, the Senate bill appears to shield current workers from cuts since participation in the new plan would be voluntary and few workers would voluntarily choose a plan where they bear more of the cost and the risk. However, even if it were a good idea to sacrifice future workers to shield current ones, current workers would nonetheless be harmed because the hybrid would siphon workers and money out of the current system, making it harder to pay down the unfunded liability.

With the exception of the provision in the Senate bill requiring full payment of the actuarially required contribution, the proposed changes to the Virginia Retirement System are extreme and unnecessary. VRS benefits are modest by national standards, with an accrual rate of 1.7% and an average benefit of less than $19,000 in 2009, compared to the national average of 2.0% and $22,438, according to the Center for Retirement Research’s Public Plans database. Meanwhile, the funding ratio is well within the norm for a state pension system in the wake of the recent market downturn: with a funding ratio of 67% in 2010, VRS ranked 63rd out of 125 plans in the database—or slightly below the 77% average (partly due to a failure to pay the full actuarially required contribution).

The Senate bill would create a new hybrid retirement program with both defined contribution (DB) and defined benefit (DC) components. The DB component would have a 1.0% multiplier that generates a 30% replacement rate after 30 years of service and requires a 4% member contribution. The current multiplier is 1.7%, so this amounts to a drastic 41% benefit cut, not counting the fact that employees would also start contributing 4% into the system.

The DC component would not fill the gap, even for the few workers who contribute 5% and receive the maximum 3.5% employer match. Workers would also bear all of the financial and longevity risk and have their savings eroded through high fees (more on this below). Since most workers would not be able to afford a 9% total DB and DC contribution, the direct VRS cost to taxpayers would likely decline once short-term transition costs are factored in. But this unrealistically assumes workers would be willing to accept both below-market wages and bare-bones benefits. Rather, since public sector workers value pension benefits above the cost to employers, the difference would have to be more than made up by higher wages in order to maintain recruitment and retention, and total compensation costs would rise even as workers’ retirement security declined. In other words, there’s no such thing as a free lunch, but the DB lunch is a better value than the DC lunch for both public employers and workers.

While the situation facing the VRS is challenging, it does not warrant the extreme measures being contemplated by the General Assembly. Taxpayers will see little benefit, yet the retirement security of public workers will be irrevocably harmed. So will the ability of Virginia public employers to attract and retain skilled workers—and the reputation of Virginia’s schools and other public services.